Efforts that have included smaller project footprints, simplified processes and standardization, technology and lower service costs resulted in a more than 41% drop last year on an index that tracks the development costs of oil and gas supermajors.
But despite improved performance, costs were still higher than they were between 2011 and 2014 when costs for materials, equipment and labor rose as oil companies faced overruns and delays, according to a study recently released by Apex Consulting’s Muktadir Ur Rahman.
Cost efficiency gains made since 2014—when lower oil prices forced supermajors and smaller companies alike to work smarter—have ushered in an era of cost control and capital discipline; however, challenges remain when it comes to cost reduction sustainability. There are ways to mitigate the risk of rising costs, and some companies are already on the path.
“Among the seven companies analyzed between 2011 and 2017, we found that Eni’s performance improved the most, followed by Chevron and Total. Although the 3-year weighted average development cost per boe went down for these companies over this period, it increased for the other four companies in line with the wider industry trend,” Rahman said in the study. “Looking ahead, 2018 may turn out to be the year when development cost deflation bottoms out, leading to a rise in the index in subsequent years. Therefore, the industry needs a new business model, one that encourages greater collaboration and appropriate risk-sharing to prevent the recurrence of the runaway.”
Focusing on BP (NYSE: BP), Chevron Corp. (NYSE: CVX), ConocoPhillips (NYSE: COP), Eni (NYSE: E), Exxon Mobil Corp. (NYSE: XOM), Royal Dutch Shell (NYSE: RDS.A)and Total (NYSE: TOT), Apex Consulting reported its so-called “supermajor cost index” for the companies fell by more than 41% in 2017 compared to 2014, but was up 16% compared to 2011.
The index is based on a formula used to measure the efficiency of a company’s development costs, which typically outweigh exploration and operating costs. As explained by Apex, the index uses a weighted three-year average to track changes in development costs. That latest index reflects cost-saving steps implemented since the downturn. A rising index signals more cost pressure across the industry, while a falling index signals an easing of cost pressure, the study states.
While most, if not all, oil and gas players have taken steps to improve efficiency, cut costs and spend less by incorporating technology and new techniques, selling assets and changing development plans, some supermajors have outperformed their peers. The study singled out Eni, Chevron and Total for their improvement in development cost per boe.
“For example, in order to manage costs better and negate the impact of sector-specific cost inflation, Eni started high-grading its portfolio, standardizing specifications, applying technologies that reduced drilling and completion times, and focusing on managing risks better and improving its project execution,” Rahman said in the study. “These steps helped reduce its development cost per boe by 55% between 2011 and 2017. As a result, by end-2017, Eni’s development cost per boe was 27% lower than that of the supermajors as a group, whereas it was almost twice the peer group average in 2011.”
A combination of major projects going online, greater technology uptake, capital discipline and portfolio high-grading helped Chevron improve its cost efficiency by 47% between 2011 and 2017 as development costs fell, the study showed.
Likewise, Total took similar steps while also taking advantage of industrywide cost deflation as did others to bring down costs amid continued portfolio high-grading and bringing major projects onstream.
“Total reduced its development costs per boe by 62% between 2014 and 2017, compared with 41% for the supermajors as a group. As a result, looking at the period between 2011 and 2017 as a whole, we estimate that Total’s cost efficiency improved by 19% during this period,” he said. “By the end of 2017, its development cost per boe had decreased from around 30% above the peer group average in 2011 to 10% below the group average.”
Whether the cost reductions are sustainable remains to be seen.
The study pointed out that while targeting third-party rates to lower costs in areas such as optimizing logistics and production operations, simplifying processes and adopting lower cost drilling techniques could relieve some pressure on costs, more activity would send costs higher.
However, Rahman offered some thoughts in the study on how to keep costs in check in the face of uncertainties involving demand, geopolitics, regulatory changes, and “protectionist measures” such as tariffs on coal, steel and other components.
“To mitigate the risk of rising costs, operators and suppliers need to work more closely towards the common goal of improving project profitability and reliability,” he said. “Not only do we need greater collaboration between operators and service providers, we also need a more transparent and shared approach to risk allocation so that oil services companies are incentivized appropriately to find innovative ways to cut costs.”
He used the integrated development model as an example. As part of the model, operators and service providers work together on all segments of the project with goals of delivering cost-effective solutions and profits, he said. “Remuneration schemes are designed to ensure that the goals of relevant stakeholders are aligned and match the project’s objectives.”
Projects involving collaboration and risk-sharing are already resulting in lower costs for some companies. For example, supermajors BP and Chevron along with partner BHP Billiton (NYSE: BHP) redesigned the Mad Dog Phase 2 project in the U.S. Gulf of Mexico. The initial design, described by BP as “too complex and costly,” prompted the company and its partners to start searching for ways to lower costs in 2013. Their efforts and those of contractors involved in the project led to a 60% drop in costs, attributable to a simpler and standardized platform design.
Some companies such as Schlumberger Ltd. (NYSE: SLB) also offer performance-based contracts and integrated projects.
“The threat of rising costs can be managed through greater collaboration and risk-sharing between operators and their suppliers,” Rahman said in the study. “This new model of collaboration with appropriate incentive structures must be guided by the overarching mantra of ‘value accretive volume growth’ to prevent the recurrence of the runaway cost escalations of the past and make the industry’s activities more resilient to adverse price movements.”
Velda Addison can be reached at email@example.com.
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